Attached at the Hip

These are unusual times for the stock and bond market.  The correlation between stocks and bonds has been extremely high for 2019.  It is especially pronounced on FOMC meeting days, when Powell was more dovish than expected (January, March, and June meetings), and when Powell was more hawkish than expected (May meeting).  Stocks and bonds rallied strongly in the dovish meetings, and sold off hard in the hawkish meeting.

Every time Powell has come out dovish, stock and bonds have screamed higher, the latest case being the Humphrey Hawkins testimony last Wednesday, July 10.  The times when bonds have been weaker, which is few and far between this year, it led to a quick equity market selloff almost immediately (early May, this past Tuesday).  Yesterday afternoon you had a dovish double barrel from Williams and Clarida which rocketed bonds higher which of course caused stocks to squeeze higher along with it.

It is now seered into the brains of equity traders that a dovish Fed is a buy signal.  But this is not a sustainable pattern, because as I mentioned before, the low rates fuel which has been driving stocks higher is mostly used up.  The stock market is going higher under the premise that the US economy is not weak, and therefore the Fed rate cuts are insurance cuts, which will ensure a longer expansion and continued earnings growth.  Thus, any dovish words from Fed officials is taken as a positive for both stocks and bonds.  The assumption is that the Fed rate cuts are a bonus for an economy that doesn't really need them, just added rocket fuel for the SPX.

I disagree with the assumption.  Not because I am a permabear.  I am looking at the leading indicators and they are all flashing red.  That is despite a face ripper of rally over the past 6 months.  Usually the leading indicators follow the stock market, as there is wealth effect from higher stock prices, as well as higher bond prices.  But despite both stocks and bonds up huge this year, the US leading indicators are SURPRISINGLY weak.
In fact, the leading indicators are hovering near the lowest levels since 2010, despite a booming stock market.

The relative strength in utilities and consumer staples, and the relative weakness in financials and energy are flashing amber lights.

Next year, you have the uncertainty that comes from the 2020 Presidential election, where the possibility of a non-Biden Democratic president becomes a palpable threat to the status quo of corporate welfare.  The short side is looking very appealing right now, and what better time than when most stock traders expect the Fed to save the market, when the insurance cuts are already priced into the market.  In order for the Eurodollars and Fed funds futures market to price in more cuts, there has to be real stock market weakness, not just 3-5% pullbacks.  I am talking at least 10% corrections.  So I don't see anymore bonds up, stocks up action for the rest of the year.  The correlations for stocks and bonds will become negative, as weak economic data is no longer treated as good news.  Bad will be bad again soon.